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January 4, 2023 –
Accessing the Public Equity Markets – Benefits and Challenges
The public equity markets have long played an important role in providing public issuers with financing necessary to grow and innovate, while giving investors access to attractive returns.1 But public issuers face unique challenges as well. In particular, investors (and analysts who report on public issuers) may overemphasize near-term financial results at the expense of longer-term objectives.
In 2013, Dell was taken private in a $24.9 billion leveraged buyout 25 years after its initial public offering on Nasdaq. A year later, the company’s eponymous CEO Michael Dell, penned an op-ed for the Wall Street Journal where he noted:
“The single most important thing a company can do is invest and innovate to help customers succeed. Theoretically this should also be good for shareholders. You do what’s best for customers, you grow and generate returns, and a stable base of long-term shareholders benefits from success… Yet we find ourselves in a world increasingly afflicted with myopia… as a public company [Dell’s] shareholders increasingly demanded short-term results to drive returns; innovation and investment too often suffered as a result. Shareholder and customer interests decoupled.”2
At the time, this observation resonated with many. As a result, the number of public issuers declined gradually for more than a decade. This development reversed in 2020: on the back of an epic bull market, the COVID-19 pandemic saw a wave of companies accessing the public equity markets for the first time, some by way of a traditional IPO, many others by merging with a publicly traded special purpose acquisition company (SPAC) (we refer in this article to the publicly traded combined business resulting from such a merger as a “deSPAC Company”).3
Among this new cohort of deSPAC Companies were many innovative startups with the potential to disrupt their industry. Those startups had long preferred remaining private and prioritizing investment and innovation over profitability. As an asset class, these privately held startups were available only to a select group of accredited investors with access to private placements, and not to retail investors. Then, the historically beneficial market conditions in 2020 and 2021 provided abundant public equity capital, and many startups heard Wall Street’s call.
However, deSPAC Companies had to adjust to public market scrutiny, and learned that public markets are volatile and cyclical. The dilemma described by Michael Dell became the new reality of this newly minted class of public issuers, aggravated by the 2022 environment of higher inflation and tighter monetary policy, increasing pessimism around the global economy, Russia’s invasion of Ukraine, supply chain issues and the continued impact of COVID-19. These factors resulted in U.S. and global stock market indices declining steeply, with the technology sector suffering the greatest losses.4 Many deSPAC Companies saw their stock price fall in 2022 and, with some exceptions, have significantly underperformed the market as a whole.5
The reasons for such underperformance are case-specific. That said, of the 10 largest IPOs from 2021, six issuers went public through the traditional IPO process while four went public through deSPAC; only one of the six traditional IPO issuers had de minimis revenue, while two of the four deSPAC issuers did.6 Also, in many deSPAC transactions, the SPAC includes projections in its deSPAC proxy/prospectus. A failure of deSPAC Companies to meet the publicly disclosed projections may intensify existing downward pressure on their stock price.7
These developments may trigger a wave of going private transactions involving deSPAC Companies. DeSPAC Companies may be facing similar pressure from investors and analysts to the pressure faced by Dell. Founders and/or senior management of deSPAC Companies may be inclined to take them private again, as did Michael Dell. Moreover, lower valuations may attract takeover advances from more mature strategics or private equity. Also, with a low stock price and higher borrowing costs,8 management of deSPAC Companies may find it challenging to unlock financing, especially important for companies still in their growth stage. That, in turn, may eventually make a sale of the deSPAC Company inevitable.
Romeo – Case Study of a “Going Private” by a deSPAC Company
It took 25 years following Dell’s IPO for it to go private. It took one deSPAC Company, Romeo, less than two.
In October 2020, Romeo Systems Inc., an electric vehicle (“EV”) battery manufacturer, announced it was going public through a merger with SPAC RMG Acquisition Corp. (“RMG”) in a deal that, at signing, valued the combined entity (“Romeo”) at approximately $1.3 billion. In its deSPAC proxy/prospectus, RMG’s projected 2021 and 2022 revenue was $139.8 million and $411.9 million, respectively, while its actual revenue was only $16.8 million in 2021 and $17.3 million for the first six months of 2022. At closing, Romeo’s stock traded in the mid-$30s (resulting in a total market cap of approximately $5.2 billion), before steadily declining; by May 2022, Romeo’s stock was trading under $1 per share.
The dramatic decline in Romeo’s share price exacerbated a liquidity crisis, and in August 2022, with a potential bankruptcy looming, Romeo and Nikola Corporation (Romeo’s largest customer, a Nasdaq-listed EV infrastructure company and itself a DeSPAC Company) announced a definitive agreement pursuant to which Nikola would make an offer to Romeo’s shareholders to exchange their Romeo stock for Nikola stock, to be followed by a merger after which Romeo would be a wholly-owned subsidiary of Nikola. The transaction was valued at approximately $67 million in the aggregate.9The transaction was completed in October 2022 – less than two years after Romeo went public.
Coming Wave of Going Private Transactions Involving deSPAC Companies?
Nikola’s acquisition of Romeo may presage a coming wave of deSPAC Companies going private. Faced with a sustained decline of the stock price, boards of directors of public issuers have to evaluate strategic alternatives. Boards of directors of DeSPAC Companies considering a going private transaction will need to consider a range of commercial and legal questions in determining whether a going private transaction is the right choice. Among others, a deSPAC Company will need to consider the following legal factors:
As summarized above, there are certain legal issues that will be commonly faced in connection with potential going private transactions. However, particularly in respect of deSPAC companies each potential transaction will be unique based on the potential target’s capital structure, management, the interests of various parties, and contractual terms by which the public issuer and its key shareholders are subject. In addition, hostile takeovers will invariably raise a host of issues not covered in this analysis.
To aid a potential acquiror or target in structuring a potential going private transaction, legal and financial advisors should be brought into the loop at the early stages of a potential transaction to help prepare a realistic and efficient path to successful closing.